FINC 322 - Chapter 6 Answers

FINC 322 - Chapter 6 Answers - Basic 1. To solve this...

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Unformatted text preview: Basic 1. To solve this problem, we must find the PV of each cash flow and add them. To find the PV of a lump sum, we use: PV = FV / (1 + r) t PV@10% = $950 / 1.10 + $1,040 / 1.10 2 + $1,130 / 1.10 3 + $1,075 / 1.10 4 = $3,306.37 PV@18% = $950 / 1.18 + $1,040 / 1.18 2 + $1,130 / 1.18 3 + $1,075 / 1.18 4 = $2,794.22 PV@24% = $950 / 1.24 + $1,040 / 1.24 2 + $1,130 / 1.24 3 + $1,075 / 1.24 4 = $2,489.88 2. To find the PVA, we use the equation: PVA = C ({1 [1/(1 + r) ] t } / r ) At a 5 percent interest rate: X@5%: PVA = $6,000{[1 (1/1.05) 9 ] / .05 } = $42,646.93 Y@5%: PVA = $8,000{[1 (1/1.05) 6 ] / .05 } = $40,605.54 And at a 15 percent interest rate: X@15%: PVA = $6,000{[1 (1/1.15) 9 ] / .15 } = $28,629.50 Y@15%: PVA = $8,000{[1 (1/1.15) 6 ] / .15 } = $30,275.86 Notice that the PV of cash flow X has a greater PV at a 5 percent interest rate, but a lower PV at a 15 percent interest rate. The reason is that X has greater total cash flows. At a lower interest rate, the total cash flow is more important since the cost of waiting (the interest rate) is not as great. At a higher interest rate, Y is more valuable since it has larger cash flows. At the higher interest rate, these bigger cash flows early are more important since the cost of waiting (the interest rate) is so much greater. 3. To solve this problem, we must find the FV of each cash flow and add them. To find the FV of a lump sum, we use: FV = PV(1 + r) t FV@8% = $940(1.08) 3 + $1,090(1.08) 2 + $1,340(1.08) + $1,405 = $5,307.71 FV@11% = $940(1.11) 3 + $1,090(1.11) 2 + $1,340(1.11) + $1,405 = $5,520.96 FV@24% = $940(1.24) 3 + $1,090(1.24) 2 + $1,340(1.24) + $1,405 = $6,534.81 Notice we are finding the value at Year 4, the cash flow at Year 4 is simply added to the FV of the other cash flows. In other words, we do not need to compound this cash flow. 4. To find the PVA, we use the equation: PVA = C ({1 [1/(1 + r) ] t } / r ) PVA@15 yrs: PVA = $5,300{[1 (1/1.07) 15 ] / .07} = $48,271.94 PVA@40 yrs: PVA = $5,300{[1 (1/1.07) 40 ] / .07} = $70,658.06 PVA@75 yrs: PVA = $5,300{[1 (1/1.07) 75 ] / .07} = $75,240.70 To find the PV of a perpetuity, we use the equation: PV = C / r PV = $5,300 / .07 = $75,714.29 Notice that as the length of the annuity payments increases, the present value of the annuity approaches the present value of the perpetuity. The present value of the 75 year annuity and the present value of the perpetuity imply that the value today of all perpetuity payments beyond 75 years is only $473.59. 5. Here we have the PVA, the length of the annuity, and the interest rate. We want to calculate the annuity payment. Using the PVA equation: PVA = C ({1 [1/(1 + r) ] t } / r ) PVA = $34,000 = $ C {[1 (1/1.0765) 15 ] / .0765} We can now solve this equation for the annuity payment. Doing so, we get: C = $34,000 / 8.74548 = $3,887.72 6. To find the PVA, we use the equation: PVA = C ({1 [1/(1 + r) ] t } / r ) PVA = $73,000{[1 (1/1.085) 8 ] / .085} = $411,660.36] / ....
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This note was uploaded on 12/13/2011 for the course FINC 322 taught by Professor Nazar during the Fall '11 term at Ferris State.

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FINC 322 - Chapter 6 Answers - Basic 1. To solve this...

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